Conscious Capitalism & Thresholds for an Exceptional Business

October 2, 2012 — 2 Comments

lucyThe Case for Conscious Capitalism

Next week Austin will play host to a group of executives that label themselves “conscious capitalists.” [See consciouscapitalism.org.] John Mackey, founder and CEO of Whole Foods, will provide the keynote address and suitably so. In 2007 he loaned his influential voice to this movement by penning the missive “Conscious Capitalism: Creating a New Paradigm for Business.”

It’s worth the read, and you can download it here. [pdf] The gist is this:

There is a longstanding prejudice that businesses exist for the enrichment of shareholders. While this is technically true, the notion has been interpreted to mean that corporate managers have the fiduciary responsibility to grab profits whenever they are available for the taking, all other constituencies be damned. It is the investor dominated viewpoint, often ignores the other stakeholders in a business, and it can be obscenely myopic. (See my related article, Whom Does Management Serve?)

It also creates, Mackey argues, a zero-sum game that pits investors against managers, employees, customers, vendors and all other stakeholders. By spending more on employee pay and benefits than absolutely necessary, for example, you’re taking earnings off the table that are the rightful property of investors. If employees win, investors lose.

The Conscious Capitalist movement argues for a different framework for understanding the game of business. Rather than a zero-sum dynamic, it suggests viewing it as a system of interconnected parts. By investing more in employee benefits, Mackey says, you get happier employees who better serve the customer…who then buys more products…which leads to higher profits…which can be shared with investors. Treat all stakeholders in a fair manner and the whole system is hoisted ever higher in a virtuous cycle. The sum of the parts, working in unison, become much more valuable than the individual components.

By way of example, here is the Whole Foods graphic that illustrates Mackey’s thinking:

wholefoods

Some acolytes of the movement (and likely attendees in Austin next week) are: Costco, Southwest Airlines, Google, Intel, Zappos and Starbucks. All are valuable franchise-quality businesses; unequivocal successes. Which begs the question:

Are they successes because they practice conscious capitalism, or are they able to practice this conscious approach because they are successes?

Ye Olde Chicken and Egg

Likewise in my study of exceptional businesses, are they successes because of the traits I’ve identified? Or can they afford to have those traits because something else drives that success?

Which comes first, the chicken or the egg?

That romantic side of me that always roots for Charlie Brown to finally give Lucy her comeuppance, to strike that football far and true before his tormentor can pull it away yet again…That side of me wants to believe these companies become great because they follow noble missions and stand tall on principle. But the realist in me knows the slog and grind of competitive business has seen too many well-intentioned people step into that kick only to see the ball yanked away. My realist knows that good intentions are not quite enough.

The graveyards of capitalism are littered with the bones of earnest entrepreneurs whose desire to do good could not overcome their naïveté about building a business.

No, I think the success stories of Conscious Capitalism, of Jim Collins’ Good to Great and Built to Last, of my own exceptional business series are first beneficiaries of a well-conceived and well-executed business premise. They have crossed over a threshold of profitability and competitive advantage that allows them to put these high principles into practice (but without which they would likely wilt under the intense klieg lights of open market competition).

You don’t, after all, see many VCR repair companies sporting the profits that allow them to make generous contributions to employee retirement plans.

The Threshold Requirements for an Exceptional Business

So what is this threshold of which I speak? I believe its requirements look something like this:

1. Demand.

The business must offer something for which there is currently demand or be so convinced of the prospects of a new product or service that it is reasonably confident in its ability to create demand in the market.

Whole Foods was correct in its premise that there could be demand for natural foods on a large scale and that shoppers would be willing to pay a premium for these groceries.

Costco was correct that it could sell tremendous bulk at a high rate of inventory turnover by offering items at the lowest price.

Apple was correct that it could create demand and succeed (where so many other electronics companies had tried and failed) if it could engineer a well-designed portable music player with a content ecosystem to support it.

2. Supply.

The business must have the ability to supply the products or services for which there is demand. Nothing could seem more obvious, but I’ve read many a business proposal from entrepreneurs who correctly intuit an opportunity yet have no reasonable means of supplying the market. (i.e., insufficient technical talent to build the technology, no access to the raw materials of production, inability to secure adequate capital, lack of access to distribution channels, etc.)

3. Viable Economic Model.

Even with the best demand for a product, coupled with the ability to supply it to the market, it is worthless if the economics aren’t viable. This means that the business must sell the goods for more than it costs to build them, market them, and distribute them.  AND – just as important but so commonly misunderstood – it must do so with enough profits to satisfy whatever capital is invested into the business. (I wrote an overview of this with An Exchange on ROIC…the Key Measure of Profitability.)

4. Competitive Advantage.

The harshest reality of the capitalist system is that profits draw competitors just as certain as chum in the water draws sharks. Consider that an unerring principle. So even upon satisfying threshold requirements one through three, a business that wants to be successful for the long haul must have competitive advantages in place that prevent bigger, smarter and better-financed foes from stealing their customers or starting price wars that drive all profits from the business. (For more information on this, you can refer to my write-ups Competitive Advantages – The Umbrella Categories and Why Is Price the Ultimate Competitive Advantage?)

Sometimes a single barrier to entry is enough. The best businesses are protected by multiple and overlapping advantages.

Beyond the Threshold, A Place for Ideals

I apply these threshold requirements to any business I invest in, and I encourage would-be entrepreneurs to consider each thoughtfully as they ponder their own ventures. With the requirements satisfied, however, there is plenty of room for Conscious Capitalism and other ideals for operating a company. But the threshold requirements are first-order, meaning you must have them in place before the high-minded principles can be applied.

Once they are, Mackey’s heuristic of the interconnected system is valid. I would go so far as saying it represents a competitive advantage in and of itself.

While my interests are tied most closely with investors, I find it is often the business that learns to ignore us (or to put it more politely, balance our demands within the system) that do best over time. Our impatience for profits is notorious, so much so that we often forego a better long-term return to satisfy our profitability bias, getting the immediate gains and getting out. That’s not to say the short-term approach is right or wrong (as the Zen master might say, it just “is”). But when a management team has long-term ambitions for a business, its interests can and will conflict with investors that have shorter horizons.

Over the long-term, I believe the profits can be substantially better with a business that rallies to a grander purpose. This gets employees excited about their jobs, providing a sense of mission that makes them feel good about what they do for a living. Happier employees, as Tony Hsieh – the Zappos CEO and conscious capitalist – so notably highlights, are more likely to work hard to keep customers happy. And happier customers come back more often. And that leads to better profits, though not always quickly.

So Godspeed Conscious Capitalists in your summit meeting next week in Austin. May you show the world how Charlie Brown can finally get the best of that menacing Lucy.

Paul Dryden

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2 responses to Conscious Capitalism & Thresholds for an Exceptional Business

  1. Paul, great conversation starter. I would add that another benefit of Conscious Capitalism is in its foundational nature to solidify a shared value across an enterprise that can, and will, productively extend outside of a company’s doors. Meet branding from the inside out. Because at the end of the day whether we categorize a business as B2C or B2B, its success is found in its ability to be P2P. People buy from people. And, more and more, we want to buy from people who share our values not just make great products.

    • Well put Beverly. I couldn’t agree more! A brand built from the inside out should exude authenticity, and I think customers of all sorts pick up on that and appreciate it.

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